The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Given the unrest in the Middle East we’re hearing a lot of noise these days about how the U.S. is totally dependent on oil imports from that region of the world.   The data, however, does not confirm these assertions.

Max Gunther set forth basic trading principles called The Zurich Axioms:

On Risk:
- Worry is not a sickness but a sign of health – if you are not worried, you are not risking enough.
- Always play for meaningful stakes – if an amount is so small that its loss won’t make any significant difference, then it isn’t likely to bring any significant gains either.
- Resist the allure of diversification.

On Greed:
- Always take your profit too soon.
- Decide in advance what gain you want from a venture, and when you get it, get out.

On Hope:
- When the ship starts sinking, don’t pray. Jump.
- Accept small losses cheerfully as a fact of life. Expect to experience several while awaiting a large gain.

On Forecasts:
- Human behaviour cannot be predicted. Distrust anyone who claims to know the future, however dimly.

On Patterns:
- Chaos is not dangerous until it starts to look orderly.
- Beware the historian’s trap – it is based on the age-old but entirely unwarranted belief that the orderly repetition of history allows for accurate forecasting in certain situations.
- Beware the chartist’s illusion – it is characteristic of human minds to perceive links of cause and effect where none exist.
- Beware the gambler’s fallacy – there’s no such thing as “Today’s my lucky day” or “I’m hot tonight”.

On Mobility:
- Avoid putting down roots. They impede motion.
- Do not become trapped in a souring venture because of sentiments like loyalty and nostalgia.
- Never hesitate to abandon a venture if something more attractive comes into view.

On Intuition:
- A hunch can be trusted if it can be explained.
- Never confuse a hunch with a hope.

On the Occult:
- If astrology worked, all astrologers would be rich.
- A superstition need not be exorcised. It can be enjoyed, provided it is kept in its place.

On Optimism & Pessimism:
- Optimism means expecting the best, but confidence mean knowing how you will handle the worst. Never make a move if you are merely optimistic.

On Consensus:
- Disregard the majority opinion. It is probably wrong.
- Never follow speculative fads. Often, the best time to buy something is when nobody else wants it.

On Stubbornness:
- If it doesn’t pay off the first time, forget it.
- Never try to save a bad investment by “averaging down”.

On Planning:
- Long-range plans engender the dangerous belief that the future is under control. It is important never to take your own long-range plans or other people’s seriously. In essence these axioms point to the benefit of having an investment strategy and sticking to it, regardless of what other investors say or do. If you don’t have an investment strategy, you could do worse than adopt these principles. However, don’t be afraid to add or subtract ones according to what works for you.

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The Zurich Axioms
A friend game me a fantastic book “The Zurich Axioms” by Max Gunther which I think any investor should read. Here is what I learnt.
“The First Major Axiom: on Risk
Worry is not a sickness but a sign of health. If you are not worried, you are not risking enough.
Minor Axiom I.
Always play for meaningful stakes.
Minor Axiom II.
Resist the allure of diversification.
Strategy
Now let’s review the First Axiom quickly. Specifically, what does the axiom advise you to do with your money?
It says put your money at risk. Don’t be afraid of getting hurt a little. The degree of risk you will usually be dealing with is not hair-raisingly high. By being willing to face it, you give yourself the only realistic chance you have of rising above the great unrich.
The price you pay for this glorious chance is a state of worry. But this worry, the First Axiom insists, is not the sickness modern psychology believes it to be. It is the hot and tart sauce of life. Once you get used to it, you enjoy it.
The Second Major Axiom: on Greed
Always take your profit too soon.
Minor Axiom III.
Decide in advance what gain you want from a venture, and when you get it, get out.
Strategy
Now let’s see just what the Second Axiom advises you to do.
It says, “Sell too soon.” Don’t wait for booms to reach their peaks. Don’t hope for winning streaks to go on and on. Don’t stretch your luck. Expect winning streaks to be short. When you reach a previously decided-upon ending position, cash out and walk away. Do this even when everything looks rosy, even when you’re optimistic, even when everybody around you is saying the boom will keep roaring along.
The only reason for not doing it would be that some new situation has arisen, and this situation makes you all but certain that you can go on winning for a while.
Expect in such unusual circumstances, get in the habit of selling too soon. And when you’ve sold, don’t torment yourself if the winning set continues without you. In all likelihood it won’t continue long. If it does, console yourself by thinking of all the times when selling too soon preserved gains you would otherwise have lost.
The Third Major Axiom: on Hope
When the ship starts to sink, don’t pray. Jump.
Minor Axiom IV.
Accept small losses cheerfully as a fact of life. Expect to experience several while awaiting a large gain.
Strategy
The Third Axiom tells you not to wait around when trouble shows itself. It tells you to get away promptly.
Don’t hope, don’t pray. Hope and prayer are nice, no doubt, but they are not useful as tools of a speculative operation.
Nobody pretends it is easy to carry out the teaching of this hard, unsentimental Axiom. We’ve looked at three obstacles to its implementation: fear of regret, unwillingness to abandon part of an investment, and difficulty of admitting a mistake. One or more of these problems may afflict you, perhaps severely. Somehow or other, you have to overcome them.
The Axioms are about speculation, not psychological self-help, and therefore they have no advice to offer on how you overcome these obstacles. That is an internal and individual process; the how is probably different for each of us. The Third Axiom says only that learning to take losses is an essential speculative technique. The fact that most men and women fail to learn the technique is one of the key reasons why most are not good speculators or gamblers.
The Fourth Major Axiom: on Forecasts
Human behavior cannot be predicted. Distrust anyone who claims to know the future, however dimly.
Strategy
The Fourth Axiom tells you not to build your speculative program on a basis of forecasts, because it won’t work. Disregard all prognostications. In the world of money, which is a world shaped by human behavior, nobody has the foggiest notion of what will happen in the future. Mark that word. Nobody.
Of course, we all wonder what will happen, and we all worry about it. But to seek escape from that worry by leaning on predictions is a formula for poverty. The successful speculator bases no moves on what supposedly will happen but reacts instead to what does happen.
Design your speculative program on the basis of quick reactions to events that you can actually see developing in the present. Naturally, in selecting an investment and committing money to it, you harbor the hope that its future will be bright. The hope is presumably based on careful study and hard thinking. Your act of committing dollars to the venture is itself a prediction of sorts. You are saying, “I have reason to hope this will succeed.” But don’t let that harden into an oracular pronouncement: “It is bound to succeed because interest rates will come down.” Never, never lose sight of the possibility that you have made a bad bet.
If the speculation does succeed and you find yourself climbing toward a planned ending position, fine, stay with it. If it turns sour despite what all the prophets have promised, remember the Third Axiom. Get out.
The Fifth Major Axiom: on Patterns
Minor Axiom V.
Beware the Historian’s Trap.
Minor Axiom VI.
Beware the Chartist’s illusion.
Minor Axiom VII.
Beware the Correlation and Causality Delusions.
Minor Axiom VIII.
Beware the Gambler’s Fallacy.
Strategy
Now let’s see specifically how the Fifth Axiom advises you to handle your money.
The Axiom warns you not to see order where order does not exist. This doesn’t mean you should despair of ever finding an advantageous bet or a promising investment. On the contrary, you should study the speculative medium in which you are interested -–the poker table, the art world, what-ever it is – and when you see something that looks good, take your best shot.
But don’t be hypnotized by an illusion of order. Your studying may have improved the odds in your favor, but you still cannot ignore the overwhelmingly large role of chance in the venture. It is unlikely that your studying has created a sure thing for you, or even a nearly sure thing. You are still dealing with chaos. As long as you remain keenly alert to that fact, you can keep yourself from getting hurt.
Your internal monologue should go like this: “Okay, I’ve done my homework as well as I know how. I think this bet can pay off for me. But since I cannot see or control all the random events that will affect what happens to my money, I know that the chance of my being wrong is large. Therefore I will stay light on my feet, ready to jump this way or that when whatever is going to happen happens.”
And that is the lesson of the Fifth Axiom. You are getting to be a smarter speculator all the time.
The Sixth Major Axiom: on Mobility
Avoid putting down roots. They impede motion.
Minor Axiom IX.
Do not become trapped in a souring venture because of sentiments like loyalty and nostalgia.

via FT Alphaville, Fitch Ratings has come up with a timeline of upcoming events that they expect will “help shape the direction” of eurozone sovereign credit quality:

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click for ginormous chart

by Richard Russell
Dow Theory Letters

Recently by Richard Russell: The Red Arrows

MAKING MONEY: The most popular piece I’ve published in 40 years of writing these Letters was entitled, “Rich Man, Poor Man.” I have had dozens of requests to run this piece again or for permission to reprint it for various business organizations.

Making money entails a lot more than predicting which way the stock or bond markets are heading or trying to figure which stock or fund will double over the next few years. For the great majority of investors, making money requires a plan, self-discipline and desire. I say, “for the great majority of people” because if you’re a Steven Spielberg or a Bill Gates you don’t have to know about the Dow or the markets or about yields or price/earnings ratios. You’re a phenomenon in your own field, and you’re going to make big money as a by-product of your talent and ability. But this kind of genius is rare.

For the average investor, you and me, we’re not geniuses so we have to have a financial plan. In view of this, I offer below a few items that we must be aware of if we are serious about making money.

Rule 1: Compounding: One of the most important lessons for living in the modern world is that to survive you’ve got to have money. But to live (survive) happily, you must have love, health (mental and physical), freedom, intellectual stimulation – and money. When I taught my kids about money, the first thing I taught them was the use of the “money bible.” What’s the money bible? Simple, it’s a volume of the compounding interest tables.

Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why. And you need a knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time.

But there are two catches in the compounding process. The first is obvious – compounding may involve sacrifice (you can’t spend it and still save it). Second, compounding is boring – b-o-r-i-n-g. Or I should say it’s boring until (after seven or eight years) the money starts to pour in. Then, believe me, compounding becomes very interesting. In fact, it becomes downright fascinating!

In order to emphasize the power of compounding, I am including this extraordinary study, courtesy of Market Logic, of Ft. Lauderdale, FL 33306. In this study we assume that investor (B) opens an IRA at age 19. For seven consecutive periods he puts $2,000 in his IRA at an average growth rate of 10% (7% interest plus growth). After seven years this fellow makes NO MORE contributions – he’s finished.

A second investor (A) makes no contributions until age 26 (this is the age when investor B was finished with his contributions). Then A continues faithfully to contribute $2,000 every year until he’s 65 (at the same theoretical 10% rate).

Now study the incredible results. B, who made his contributions earlier and who made only seven contributions, ends up with MORE money than A, who made 40 contributions but at a LATER TIME. The difference in the two is that B had seven more early years of compounding than A. Those seven early years were worth more than all of A’s 33 additional contributions.

This is a study that I suggest you show to your kids. It’s a study I’ve lived by, and I can tell you, “It works.” You can work your compounding with muni-bonds, with a good money market fund, with T-bills or say with five-year T-notes.

Rule 2: DON’T LOSE MONEY: This may sound naive, but believe me it isn’t. If you want to be wealthy, you must not lose money, or I should say must not lose BIG money. Absurd rule, silly rule? Maybe, but MOST PEOPLE LOSE MONEY in disastrous investments, gambling, rotten business deals, greed, poor timing. Yes, after almost five decades of investing and talking to investors, I can tell you that most people definitely DO lose money, lose big time – in the stock market, in options and futures, in real estate, in bad loans, in mindless gambling, and in their own business.

RULE 3: RICH MAN, POOR MAN: In the investment world the wealthy investor has one major advantage over the little guy, the stock market amateur and the neophyte trader. The advantage that the wealthy investor enjoys is that HE DOESN’T NEED THE MARKETS. I can’t begin to tell you what a difference that makes, both in one’s mental attitude and in the way one actually handles one’s money.

The wealthy investor doesn’t need the markets, because he already has all the income he needs. He has money coming in via bonds, T-bills, money market funds, stocks and real estate. In other words, the wealthy investor never feels pressured to “make money” in the market.

The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art or fine jewelry or gold is on the “give away” table, he buys art or diamonds or gold. In other words, the wealthy investor puts his money where the great values are.

And if no outstanding values are available, the wealthy investors waits. He can afford to wait. He has money coming in daily, weekly, monthly. The wealthy investor knows what he is looking for, and he doesn’t mind waiting months or even years for his next investment (they call that patience).

But what about the little guy? This fellow always feels pressured to “make money.” And in return he’s always pressuring the market to “do something” for him. But sadly, the market isn’t interested. When the little guy isn’t buying stocks offering 1% or 2% yields, he’s off to Las Vegas or Atlantic City trying to beat the house at roulette. Or he’s spending 20 bucks a week on lottery tickets, or he’s “investing” in some crackpot scheme that his neighbor told him about (in strictest confidence, of course).

And because the little guy is trying to force the market to do something for him, he’s a guaranteed loser. The little guy doesn’t understand values so he constantly overpays. He doesn’t comprehend the power of compounding, and he doesn’t understand money. He’s never heard the adage, “He who understands interest – earns it. He who doesn’t understand interest – pays it.” The little guy is the typical American, and he’s deeply in debt.

The little guy is in hock up to his ears. As a result, he’s always sweating – sweating to make payments on his house, his refrigerator, his car or his lawn mower. He’s impatient, and he feels perpetually put upon. He tells himself that he has to make money – fast. And he dreams of those “big, juicy mega-bucks.” In the end, the little guy wastes his money in the market, or he loses his money gambling, or he dribbles it away on senseless schemes. In short, this “money-nerd” spends his life dashing up the financial down-escalator.

But here’s the ironic part of it. If, from the beginning, the little guy had adopted a strict policy of never spending more than he made, if he had taken his extra savings and compounded it in intelligent, income-producing securities, then in due time he’d have money coming in daily, weekly, monthly, just like the rich man. The little guy would have become a financial winner, instead of a pathetic loser.

RULE 4: VALUES: The only time the average investor should stray outside the basic compounding system is when a given market offers outstanding value. I judge an investment to be a great value when it offers (a) safety; (b) an attractive return; and (c) a good chance of appreciating in price. At all other times, the compounding route is safer and probably a lot more profitable, at least in the long run.

Reprinted with permission from Dow Theory Letters.

These are the articles I have open on my laptop for in-flight reading:

• Is this bull market almost over, or will it thrive for years? (USA Today)

• BRICs Losing for Second Time in Decade as America Takes Over (Bloomberg)

• U.S. Pushes “Cramdown” Mortgage Deal (WSJ)

• BofA’s legal woes from Countrywide worse than expected (LATimes) see also Legacy Countrywide mortgage investors rally against potential settlement with Bank of America (FT.com)

• Market Crash 2011: It will hit by Christmas (Marketwatch)

• Farmers Can’t Meet Demand as Corn Stocks Drop to 1974 Low (Bloomberg)

• It’s the Inequality, Stupid (Mother Jones) see also Soak the Super-Rich (Balloon-Juice)

• Political Unrest in North Africa and the Middle East (NYT)

• The Billion Dollar Lost-Laptop Study (Intel)

• Google Forecloses On Content Farms With “Farmer” Algorithm Update (SearchEngineLand)

• Less Virtual Keypad for the iPhone (Gadgetwise)

Anything else worth reading when I land?

Work-life balance, says Nigel Marsh, is too important to be left in the hands of your employer. At TEDxSydney, Marsh lays out an ideal day balanced between family time, personal time and productivity — and offers some stirring encouragement to make it happen.

Nigel Marsh is the author of Fat, Forty and Fired and Overworked and Underlaid.

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via TED

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Here is my mantra regarding so-called ‘unsustainable’ debt levels. I feel strongly about this topic so I’ll repeat it and show you a few statistics on consumer debt from the recent US government data:

[P]oor quality growth can continue for very long indeed. And it is this fact which allows the narrative of easy money and overconsumption to gain sway.

The boy who cried wolf

A soothsayer who counsels against this type of economic policy, but who warns of impending collapse will surely be seen as the boy who cries wolf. Think back to 2001 or 2002. Did we not witness then the same spectacle whereby the bears and doomsayers were let out of their holes to warn of impending doom from reckless economic policy? By 2004, unless these individuals changed their tune, they were long forgotten or even laughed at – only to resurface in 2007 and 2008 with their new tales of woe. Knowing this shapes the psychology of economic forecasting and is why missing the turn is disastrous for one’s career. Efforts to avoid missing the turn are also part of a very large pro-cyclical psychological force underpinning a cyclical bull market.

The fact is: low quality growth does not lead to immediate economic calamity. It can continue through many business cycles.

-Is economic boom around the corner?, Sep 2009

See, things don’t move in a straight line – not on the way up and not on the way down. The problem with big macro calls is all about timing. When it comes to the ‘New Normal’, the balance sheet recession, deleveraging or whatever moniker you want to put on this post-crisis world, there are plenty of ways to forestall the inevitable.

Here are the assumptions to the macro story I have been peddling since about March or April of 2009:

Assumptions

1. Kicking the can down the road is par for the course. Politicians are loath to take bitter pills and will usually do whatever they can to cover-up systemic problems. (See A few thoughts about the euro crisis and the psychology of change)
2. Monetary and fiscal stimulus work. How do you cover up a systemic problem? Well, when one injects a lot of money into the system, it does boost the economy. Government has an unlimited arsenal of money printing and fiscal stimulus it can provide in a fiat currency system. The question is how much will they inject and how well spent is the money. (See Is economic boom around the corner?)
3. Government has a vested interest in the status quo. The reason government covers up is that crisis usually exposes bad decisions. It’s Warren Buffett’s aphorism “when the tide goes out, we see who’s been swimming naked.” If government is filled with people who can be blamed for the problem, basic human psychology says they will cover it up and hope for the best. (See A few comments about Tuesday’s election’s impact on the economy)
4. When bad things happen, government has the power to make these things go away by changing rules. The best way to cover up is to simply change the rules of the game – pass new legislation, not enforce rules, manipulate data, etc. This covering up can forestall a crisis for years. The question as to whether forestalling becomes prevention depends critically on whether the root causes of a crisis are dealt with (See The Fake Recovery)
5. Doom merchants lose credibility by not appreciating this. If you are going to market a story of angst and woe, you had better have some nice qualifiers in case things don’t go pear-shaped, because you lose all credibility if they don’t. Why?  People don’t like doom merchants. People want you to tell them all is well. Even  Cassandra was not listened to; that’s a parable for doom merchants to heed (see The psychology of economic forecasting).
6. Usually, forestalling doesn’t become prevention. ‘Growing’ your way out of a crisis is a bad way to deal with systemic issues. Usually what happens is that people lose their way because the forget about the systemic issues altogether until another downturn brings those issues into view.
7. Pollyannas will eventually also lose credibility. Because forestalling doesn’t lead to prevention, those who cry, “It’s all good” on the way down to an eventual bust are found out as charlatans. It’s not all good. And there is nothing wrong with saying so. We should hope for a good outcome but we must also make the necessary preparations for downside risk – as individuals, companies and as a collective whole. (see Geithner: jusqu’ici tout va bien)

Those are the assumptions that led me to my post “The recession is over but the depression has just begun“. Those are also the same set of assumptions that made me Cautiously Optimistic Into 2011, by the way.

Read the rest of this entry »

Alain Bokobza of the Société Générale Quant team, writes that their “Economic surprise indicator” suggests risky assets are now technically vulnerable:

“After undergoing a massive rally since last September, risky assets are now technically vulnerable: SG Quant sentiment indicator is close to an all-time high, economic revisions have rarely such a high percentage of upgrades, equity volatility is at a four-year low, the Canadian dollar is dear versus the USD and lastly inflows into equities reached $8bn last month, led by “panic-buying.”

This  economic surprise indicator is a measure of the deviation of economic data surprises, calculated as the difference between figures released and figures expected by consensus. Global Equities relative to Global Bonds: 3-month performance of MSCI World Index (in US$, in total return) divided by Barclays Global Bond Index (in US$, in total return).

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Economic Surprise Indicator

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Bonds no longer expensive vis à vis equities

1 & 3: time to switch out of bonds into equities
2 & 4: time to switch out of equities into bonds

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Source:
Don’t despair: correction of risky assets likely coming soon
Alain Bokobza, Roland Kaloyan, Arthur van Slooten, Philippe Ferreira
Multi Asset Snapshot, Société Générale Quant Group
Asset Allocation Strategy

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A quick note on Oil futures in the US: They are showing $96 on mideastern unrest. In the Us, rising gas prices, and increasing airfares are yet another economic headwind to deal with.

I assume that the middling US economy can absorb a few weeks or even months of elevated fuel prices in its current vulnerable state, but if fuel prices remain high for ore than a few months, it spells trouble.

Read the rest of this entry »

SEMINAR: Understanding Today’s Housing Market, 1Q11
April 4, 2011 – 4:00 pm-7:15 pm
Scandinavia House, 58 Park Avenue (at 38th Street), New York, NY

Jonathan Miller, President and CEO of Miller Samuel Inc. and author of the Prudential Douglas Elliman Market Overview report series, will present the state of the market in the first part of the seminar followed by an extensive Q&A period.  The seminar will encourage audience participation with i>Clicker, a technology used in many colleges to provide immediate feedback during polling.  In the second half of the seminar, Mr. Miller will interview Barry Ritholz, CEO/Director of Equity Research of Fusion IQ, Author of  Bailout Nation and the engine behind The Big Picture blog.  Mr. Ritholtz will provide “the big picture” on the economy and its impact on housing.

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